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Jon Talton

Analysis and commentary on economic news, trends and issues, with an emphasis on Seattle and the Northwest.

June 25, 2010 at 10:00 AM

Financial ‘reform’: Big bankers cry all the way to the…

I regret to inform you that the financial reform will require quotation marks. As in, financial “reform.”

The most promising real reform, the so-called Volcker Rule, which would have prohibited banks from speculating with their own capital and taking stakes in hedge funds, was gutted late in the night. This trading activity is ultimately backed by taxpayers, both because of the FDIC guarantee and easy availability of cheap money from the Fed — and it’s a major profit center for the big banks. Also watered down: A measure that would have forced the big banks to move derivatives trading into subsidiaries with their own capital support.

MIT’s Simon Johnson, one of the best chroniclers of the meltdown predicted as much earlier this week: “At the end of the day, essentially nothing in the entire legislation will reduce the potential for massive system risk as we head into the next credit cycle.”

Johnson continued:

Simply claiming that the president is “tough” on big banks simply will not wash. There are too many facts, too much accumulated evidence, pointing exactly the other way. The president signed off on the most generous and least conditional bailout in world financial history. This is now widely understood. The administration has scrambled to create some political cover in terms of “reform” – but the lack of substance here is already clear to people who follow it closely and public perceptions will shift quickly.

One unknown is whether the “reform” gives the big banks yet more advantages over the community banks that provide so much local lending to small businesses. Will the cost of funds be even cheaper for the big playerz, who would rather trade and concoct “innovations” than engage in the kind of traditional banking that helps create jobs?

The consumer protection agency is fine, but it mostly represents a consolidation of existing laws and agency oversight. As we learned in the financial panic, laws and regulations are only worthwhile when they are enforced. And the power of the big banks is so great that it necessarily includes “regulatory capture,” where the regulators are pressured to look the other way. Regulators largely had the tools to stop the run-up to the crash; they didn’t use them, both because of ideological bias and because of the scratch Big Finance can throw into the political machine.

Ironic how this bill could move ahead while one to extend unemployment benefits stalls. The private sector simply isn’t hiring, but no matter. Those cut-loose worker drones don’t have hundreds of millions of dollars with which to buy a Senate.

Needless to say, the “reform” doesn’t touch the too-big-to-fail banks or much of the highly risky shadow banking system. Perverse compensation incentives remain, as does the monopoly of the ratings agencies. The bill doesn’t do much to regulate or provide transparency for the derivatives action that too often proved to be swindles. High levels of leverage, a key driver of the bubble, remain untouched. Fannie Mae and Freddie Mac likewise avoided this “sweeping,” “transformation,” “biggest financial reform since the Great Depression.”

Hardly. Finance leading up to the crash of 1929 was speculative, leveraged and full of fraud, but it wasn’t today’s complex, highly interconnected casino — with taxpayers on the line. And the reforms then were real: Winding down weak banks, establishing the FDIC, creating the Securities and Exchange Commission and passing Glass-Steagall, which prevented a rerun of the disaster until it was repealed in 1999.

So the gun that fired the shot that nearly brought down the world economy remains in the same hands, locked, cocked and ready to go off when we least expect it. Our national security and living standards will be at stake. But what’s that compared against next week’s trading profits for the elite?

Today’s Econ Haiku:

Those whining bankers

Are smiling behind their tears

A fine whine indeed

Comments | More in Bailout, Banking


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